Warsh is Wrong About Inflation

SUMMARY

Joe Brown, a former stock broker and financial educator, analyzes Kevin Warsh's recent statements as Federal Reserve chairman, focusing on the effectiveness of current monetary policy in controlling inflation. Brown argues that Warsh's reliance on short-term interest rates is insufficient and highlights the critical role of money supply growth versus production in determining price levels.

MAIN POINTS

• Kevin Warsh asserts the economy is resilient, with S&P 500 earnings showing rapid growth. [0:40]
• Wages have increased significantly since 2020, outpacing previous trends and challenging the narrative that wage growth lags behind living costs. [2:10]
• A high number of job openings suggests unemployment statistics may be less relevant in assessing labor market health. [4:10]
• The Federal Reserve's control over the money supply and interest rates means it remains the primary driver of the bond market, regardless of its stated intentions. [6:10]
• Inflation is closely tied to the growth of the money supply relative to the production of goods and services, not just short-term interest rates. [9:00]
• Raising short-term rates without addressing money supply growth risks causing a severe economic downturn rather than achieving stable inflation. [12:50]

DETAILED ANALYSIS

Kevin Warsh's recent speech as Federal Reserve chairman emphasized the strength of the U.S. economy, citing robust earnings growth in the S&P 500 and advancements in areas like artificial intelligence and employment. Current data supports this view, with S&P 500 earnings growing at their fastest rate since 2021 and average hourly wages rising from under $30 in 2020 to over $37, marking a nearly 25% increase. This wage growth also exceeds the pre-2020 trend, contradicting claims that wages have stagnated relative to living costs.

The labor market's health is further illustrated by the presence of over 7 million job openings, indicating that unemployment statistics alone may not fully capture economic conditions. Many available jobs remain unfilled, suggesting that factors such as job desirability, required skills, and alternative income sources play significant roles in labor participation.

Warsh's desire for the Federal Reserve to act as a passive observer in the bond market is challenged by the institution's direct control over the money supply and short-term interest rates. This central role ensures that market participants will always react to Fed policy changes, regardless of any attempt to reduce forward guidance or market signaling. The Fed's influence on the price of money means it cannot avoid being the primary market driver.

A key criticism of Warsh's approach is the reliance on short-term interest rate adjustments to control inflation. Historical data shows a strong correlation between the growth rate of the money supply and consumer prices. When the money supply expands faster than the production of goods and services, inflation results.

Conversely, increasing production without expanding the money supply can lead to lower prices. Thus, simply raising rates can inadvertently make production more expensive, slow economic growth, and even exacerbate inflation if money supply growth is unchecked. Achieving stable prices requires both controlling money supply growth and fostering an environment that allows for increased production, such as through deregulation and reduced government intervention.

Focusing solely on interest rates risks triggering a severe economic downturn without effectively curbing inflation.

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